4 July 2018
Asian foreign exchange in tariff tantrum

The near-term outlook for Asian currencies is unambiguously negative – further out, the scope for some recovery remains

Trade war is upon us

It seems as if we've been talking about trade wars for months now yet until this week, no tariffs had actually been levied, and some still hold out hope that a trade war can be averted.

We think it's getting too late for that. We sense that the Trump administration feels the global trade environment is unfair, that tariffs can help redress the balance in the US’ favour and that it can win a trade war. We disagree with both the premise and the solution - but that doesn’t change anything. Tariffs are coming, and some have already arrived.

With tariffs we expect global trade growth to worsen. This is going to be important in terms of local Asian currency (FX) strength, but exactly how much and for how long is a more complicated story.

Let’s start by considering the relationship between global trade and Asian currency strength.  The figure below shows world trade in USD plotted against both the ADXY index (index of nominal Asia ex-Japan currencies) and the headline CRB commodity index.

Where next for global central banks?

Everything you need to know about central bank policy around the world

Federal Reserve: A steady climb

The Federal Reserve is sticking to its 'gradual' policy normalisation plan, which essentially means a rate hike every quarter. However in the near term, the balance of risks is skewed towards swifter action despite financial market pre-occupation over the potential for a tariff-led trade war.

The economy looks set to grow 4% annualised in 2Q18, buoyed by tax cuts, after a 'soft' 2% in 1Q18 while inflation continues to edge higher with headline CPI set to hit 3% YoY in the next couple of months. At the same time, employment growth is averaging 207,000 per month YTD in 2018 versus the 182,000 monthly average in 2017 and you have to go all the way back to December 1969 to find a lower unemployment rate.

For now, corporate America is sanguine on the trade situation. Business surveys are strong given robust demand, but should tensions escalate and trade barriers go up, growth may moderate. This could lead to a slower pace of interest rate hikes in 2019, but the process is unlikely to stop. The tightness in the labour market and rising pay pressures will continue to support both consumer demand and inflation.

Australia’s Reserve Bank holds rates at 1.5%

Governor Lowe delivers a statement that is low on excitement, but which contained marginal hints of concern

21 months of inaction, none imminent

No one anticipated any change in the Reserve Bank of Australia's policy rate today, and none came. Few if any would have looked for any hint of change in the accompanying statement. Again, they were rewarded with none. 

But for those who are content to focus on minutiae, there was a subtle, almost imperceptible shift of sentiment to a more negative outlook. No, this was not a repeat of the RBNZ's Governor Orr suggestion that there was two-way rate risk. But there were a couple of little niggles that might become bigger niggles over time, and are worth watching. 

Reasons to be cautious

The following are the small hints from the statement that things might not be quite as good as they have seemed.

  1. One uncertainty regarding the global outlook stems from the direction of international trade policy in the United States.
  2. There have also been strains in a few emerging market economies, largely for country-specific reasons.
  3. There has been a broad-based appreciation of the US dollar.
  4. In Australia, short-term wholesale interest rates have increased over recent months. 
  5. One continuing source of uncertainty is the outlook for household consumption
  6. Australia's terms of trade are...expected to decline over the next few years
  7.  Wages growth remains low. This is likely to continue for a while yet
  8.  Conditions in the Sydney and Melbourne housing markets have eased, with prices declining in both markets.

It isn't all gloom, and the rest of the statement makes upbeat reading. But taken in isolation, the sum of these comments does amount to a non-negligible total.

This isn't enough to overturn the sense that the next move for the RBA is to tighten, but a few more statements like this developing the themes above further, and there won't be much to choose between the RBA and the RBNZ stance.

Reading time around 4 minutes

Good MornING Asia - 4 July 2018

The near-term outlook for Asian currencies is unambiguously negative – further out, the scope for some recovery remains

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